Weekend Reading for Financial Planners (Jun 13-14)

Executive Summary

Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the news that now TD Ameritrade is joining the “robo” race with a direct-to-consumer offering that will expand its current Amerivest program to compete against the likes of Vanguard and Schwab, including a new “Private Client Services” that may potentially compete against the RIAs who use TDA’s custodial services, too. And also in the news this week was the announcement that Pershing is launching its own robo-advisor-for-advisors solution, partnered with newcomer Marstone.

From there, we have a few technical planning articles this week, from a look at important IRA-rollover-related “goofs” to avoid, to a discussion of the potential crackdown coming on Family Limited Partnership (FLP) valuation discounts via new Treasury Regulations that may soon be issued, and also a discussion of how income annuities may better support the fixed-income portion of a retirement portfolio over just using traditional bonds.

We also have several practice management articles, including: how advisors are increasingly adopting “virtual” location-independent business models that serve clients through telephone, email, and video conferencing technology; a discussion of how advisors operating as a sole proprietorship or single-member LLC could be creating client continuity planning problems; a look at the benefits of “reverse mentoring” (where experienced advisors take on a Millennial to get their own mentoring about today’s 20- and 30-somethings); how employees at many advisory firms are actually quite unhappy, and why the fix is not just to pay them more; and a discussion of best practices to try to minimize employee turnover and retain to advisory firm talent.

We wrap up with three interesting articles: the first is a look at whether the whole concept of monthly “budgeting” is overrated or outright impossible, as research increasingly shows the reality is simply that our income and expenses are not as stable and consistent as a typical budgeting process would imply; the second is an in-depth look at how a credit bureau “security freeze” works and why advisors might consider it for themselves and their clients; and the last is a discussion of whether Wall Street’s threat to abandon small investors if the DOL’s fiduciary comes to pass may be both an empty threat, and one that is irrelevant because if Wall Street does abandon small investors, there are other organizations like Garrett Planning Network, XY Planning Network, and more, ready and waiting to fill the void.

And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end, including the announcement of Pershing’s new partnership with robo-advisor-for-advisors Marstone, recent major growth milestones for advisor-client PFM solution Wealth Access, and a new open-sourced wealth management platform that advisory firms might develop for their own use, called Wealthbot.io.

IRA Rollover Goofs to Avoid (Ed Slott, Financial Planning) – A recent IRS ruling illustrates how relatively simple IRA rollover rules can be botched, even when multiple experts are involved. In this case, the IRA owner wanted to use IRA funds to purchase some real estate. So he took two cash distributions from his IRA (on February 1st and 6th of 2013), and used the funds to purchase the investment real estate. However, the property was mistakenly never retitled into the IRA, running afoul of the 60-day rollover requirement, and as a result the IRA owner submitted a Private Letter Ruling to ask the IRS for an extension to the rollover rule to fix the mistake. The IRS refused, noted that even though the IRA owner stated he had an illness for part of the time period, he had not sufficiently demonstrated that his failure to complete the rollover was due to circumstances beyond his control (not the least because he did otherwise continue to manage his own financial affairs during this time period). Notably, the IRS has historically allowed leniency on the rollover rule when a botched rollover is due to the taxpayer’s reliance on outside professionals who gave bad advice, although in this case the IRA owner didn’t even “blame” outside professionals. Though ironically, Slott notes that even if the IRS did allow an extension for the rollover on this basis, the transaction was still fatally flawed. The first reason is the so-called “same property rule”, which stipulates that when doing an IRA-to-IRA rollover, the property distributed from the original account must be the same as the type of property contributed to the receiving account; so since cash was distributed, it would have had to be cash for the rollover, so if the client wanted to buy real estate he should have transferred the cash to a new self-directed IRA and then bought the new real estate inside the IRA from the start. In addition, the fact that the IRA owner did two distributions (on February 1st and 6th) means not all the funds were even eligible for rollover, because the second distribution would have run afoul of the once-per-year IRA rollover rules anyway!

Anticipating New Regulations On FLP Discounts Under IRC Section 2704 (Jonathan Blattmachr & Matthew Blattmachr, Trusts & Estates) – Gifting assets to remove them from an estate has long been a popular strategy for estate planning, and is often further leveraged by transferring assets into a Family(-controlled) Limited Partnership (FLP) that can be valued at a discount for transfer purposes. Back in 1990, Congress enacted IRC Sections 2701 to 2704 in order to at least partially limit these strategies. In particular, IRC Section 2704(b) limits valuation discounts by stipulating that certain types of “applicable restrictions” (which would result in valuation discounts” are ignored when property is transferred to or for the benefit of other family members. For instance, the rules initially stated that if liquidation terms are more restrictive than the default under state law and the family (collectively) can change it later, the restriction is ignored (which would limit any marketability valuation discount) – though over the past several decades, many states have changed their default rules under state law to be more restrictive, specifically so this valuation-discount-limitation will no longer apply! Accordingly, Congress is looking to crack down again, potentially expanding IRC Section 2704 to include additional forms of restrictions that would be disregarded, with the net result of limitation FLP valuation discounts; in fact, recent White House budget proposals contained in the Treasury Greenbook included provisions that would make such changes to the rules. Blattmachr suggests that the crackdown may exempt actual operating companies, and specifically target “holding” entities instead (i.e., the typical FLP). Notably, those proposals were eliminated from the recent 2014 and 2015 Treasury Greenbooks, but only because it appears that the Treasury may be preparing to issue its own new regulations to limit the strategy (and has determined that it doesn’t need Congress’ assistance after all), which means the time window for executing a transfer strategy may be limited.

More Advisers Are Embracing The Virtual World (Liz Skinner, Investment News) – A growing number of advisors are eschewing having a physical advisory firm office space at all, and are opting instead to work virtually with clients to deliver online financial advice, forming a client base of people the advisor may have never actually met in person. Instead, client communication occurs primarily via video conference (e.g., Skype or FaceTime), along with telephone calls and email correspondence. According to a recent Investment News survey, across the industry adoption of video conferencing is still fairly low – at approximately 4% of advisors – but is on the rise, with a whopping 32% of advisors expecting to be relying on video conferencing for regular client communication in the next 5 years. And notably, using such new technology is not just about serving tech-savvy Millennials in their 20s and 30s; older clients who have hectic jobs, a lot of travel, are trying to manage kids and a two-income household, or perhaps who are just “tech-savvy” are expressing an interest in virtual meetings, and a recent McKinsey report notes that the virtual advice model wouldn’t already be making the strides it is today if a substantial number of affluent clients weren’t already comfortable with the medium. And while clients seem increasingly willing to adopt virtual meetings, it’s also an efficiency (and therefore potential profit) improvement for advisors, as client meetings can be scheduled closer together (back-to-back) when there’s no driving/travel time between each client appointment. Though advisors using such an approach should also be cognizant of managing client information security as data is shared virtually, and will want to invest in high-quality equipment to help support their perceived professionalism with clients.

The Perils Of Advisor Sole Proprietorships And Single-Member LLCs (Chris Stanley, ThinkAdvisor) – Advisor continuity planning has become an increasingly hot topic lately, driven in no small part by the creation of a new NASAA Model Rule on Business Continuity (and Succession Planning). The key distinction is that while succession planning is about designing an exit strategy while the advisor is alive and active, continuity planning is primarily about planning for the advisor’s death, disability, or incapacitation. And as Stanley points out, in the continuity context, the type of business entity of the advisor has a major impact on the potential continuity for clients. For instance, with a sole proprietor advisory firm – where the advisor and the business are one and the same – the death of the advisor means the death of the business, which in turn brings about the immediate termination of all advisory contracts and client agreements. Thus, even if there are staff or family members designated to help clients after the death of the advisor, they may not legally be able to do so (at least, not until a new advisory contract is signed). Forming a business entity like an LLC may help, although notably in many states a single-member LLC must still be wound down at the death of the primary owner (and may even require wind-down with multiple owners if the LLC operating agreement wasn’t properly drafted for continuity, or has conflicts with any other Wills or trusts that are a part of the estate plan). The bottom line, though, is simply that from the post-death continuity perspective, the type of business entity the advisor has for his/her advisory firm matters, a lot!

The Benefits Of Reverse Mentorship (Mark Tibergien, Investment Advisor) – Accumulated experience can help bring about the wisdom to better process facts and have better perspective on complex situations. This is ultimately why it can be so beneficial to have a mentor who has already been down the path you’re pursuing. However, Tibergien notes that even experienced professionals still have much to learn (and failure to recognize this can result in hubris, a state of exaggerated self-confidence based on the belief that one has seen it all). Accordingly, Tibergien puts forth the idea of establishing a “reverse mentoring” relationship – a practice he has implemented at Pershing, where members of the executive committee are paired with Millennial employees to gain a fresh perspective. Tibergien paired himself initially with his reverse mentor, Kayla Flaten, to try to better understand the power of social media and become more proficient with technology, though he notes that ultimately his greatest insights came in recognizing how he might change the way he interacts and communicates with younger employees. Notably, many advisors already say they get much of this perspective from their own children, but Tibergien suggests it’s a different (and more enlightening) experience with a properly structured reverse mentoring relationship, which should include several key elements: the mentee should not be a direct report of the mentor; both parties should agree on a structure (ad-hoc conversations or more formal agenda); meetings should be scheduled on a regular basis; each party needs to give (and be open to) constructive feedback; and organizational hierarchy should be left outside (while respecting and maintaining confidentiality as appropriate). Given the challenge of doing this in a small-firm environment, Tibergien suggests several advisors might come together and essentially ‘trade’ reverse mentor relationships with each others’ Millennial employees.

Go Beyond Compensation to Keep Employees Happy (Angie Herbers, Investment Advisor) – A recent study entitled “2015 Trends In Advisor Compensation And Benefits” from the FPA found that while there are many differences across types of advisory firms (and the FPA study was very wide-ranging), one notable consistency is that most owner-advisors and team leaders don’t understand what makes employees satisfied, or why employees quit their jobs. In fact, a key finding of the study was that while overall 77% of those surveyed are very or somewhat satisfied with their jobs, only 22% of support staff agreed with the statement; in other words, those running advisory firms tend to be satisfied, but those working in them, not so much. Accordingly, the survey also found that 26%(!) of staff said they plan on leaving their firms in the next 2 years. In addition, the study found that while most advisory firm decision-makers stated that employees left because they weren’t a good fit for the job or were deciding to change careers, employees only indicated that “fit” and “desire to change careers” were the driving factors 3% and 6% of the time (respectively), and instead noted that compensation and lack of satisfaction in the work environment were the primary reasons for leaving. Though ultimately, Herbers suggests that satisfaction is more likely the driving factor, as in practice unhappy employees invariably point to compensation as a source of unhappiness even what that’s not actually the source of the unhappiness (perhaps due to the implied hope that they’d improve their otherwise-unhappy situation if only they were paid more?). Which means the best way to retain employees is more about investing in their professional development and making them feel appreciated, then just trying to throw more money at the problem.

How to Keep Top Talent From Leaving (Kelli Cruz, Financial Planning) – For an advisory firm, employees are both the largest cost to the firm, and as a service business are also the foundation upon which the firm’s entire value proposition is built. Accordingly, investing in your staff is key to continue to enhance the value of the business, and retaining them is crucial to ensure that the business doesn’t lose ground. The first step for good retention is simply to have well-documented job descriptions, so employees – or even candidates as they come in to become an employee – have a clear understanding of what’s expected of them, and to ensure that expectations are properly managed. If a situation doesn’t work out, be certain to do an “exit interview” when an employee leaves, to learn what could be fixed; in addition, Cruz suggest doing “stay interviews” with the firm’s best long-tenured employees, to find out why they have stayed and what the firm is doing well and should reinforce. The next step for good retention is to recognize that most employees today – especially younger ones – are ultimately looking for advancement and opportunity, so having a career path of how the employee can advance in the firm over time is crucial to keep the best (and most upward-bound) team members. And remember, an ‘ideal’ career path should not just be a single path forward, but include the potential for lateral moves, as sometimes employees just need fresh new challenges and want to do something different (but without leaving!). Giving regular feedback is also crucial; if there’s no formal process for employee reviews, then there’s a risk that employees will not even realize they aren’t meeting expectations, or feel underappreciated for what they are doing, or that their expectations will get out of whack over time. Of course, in the end remember that sometimes turnover can be good – if a poor performer has managed to slip into the firm, having them leave isn’t necessarily bad – though clearly persistently high turnover is a serious issue, implying either the firm has a poor hiring/screening process in the first place, or isn’t effectively managing the team.

Toss Your Budget (Helaine Olen, Slate) – Despite the ‘conventional wisdom’ of budgets, a recent Gallup poll found that only about 1/3rd of Americans even keep formal tracking of their inflows and outflows (and an Experian Consumer Services study estimated it’s only slightly higher at 39% of us). As it turns out, the primary issue may simply be that the concept of a steady monthly financial budget does not conform to the realities of most people’s financial lives, which are not nearly so consistent. A recent report from JPMorgan Chase Institute found that more than 80% of the bank’s customers experience a greater-than-5% change in both money coming in and their overall spending on a month-to-month basis; 25% of us see a variation greater than 30%(!) from one year to the next! This perhaps isn’t surprising, given that income itself fluctuates more in our increasingly freelancer-based economy (from outright freelancing gigs, to those who earn money through companies like Uber or Airbnb). Though notably, the study also found that spending changes don’t necessarily align neatly to income fluctuations; 60% of us vary our spending by more than 30% at least occasionally, even if income hasn’t changed, given all sorts of moderate “spending shocks” that can arise (from outright emergencies to pet emergencies to just the irregularity of paying for kids’ summer camp or gifts during the holiday season). Ironically, Olen notes that historically, budgets were actually more about spending than saving anyway; early versions were about budgeting to pay the bills for newly created layaway and installment plans offered up by stores like Sears Roebuck! So what’s the alternative? Perhaps worry less about overt budgeting, and more about just tracking and monitoring spending more effectively in the first place; for instance, one study found that when users installed Personal Capital’s personal finance app (which tracks spending), people reduced their spending by 15% (and their grocery bills by 20%) in the subsequent four months, ostensibly just by reflecting on the feedback of the data alone.

How I Learned to Stop Worrying and Embrace the Security Freeze (Brian Krebs, Krebs On Security) – As the volume of announcements on personal data breaches just continues to rise (this week, it was the revelation that Chinese hackers may have gotten the records of 4 million government workers), “crooks” (both foreign and domestic) already have access to the information needed to open new lines of credit or file phony tax refund requests in the names of millions and millions of Americans. And while when most breaches happen, you do receive 1-2 years’ worth of free credit monitoring services, the problem is that those really don’t prevent ID theft, they just notify you if ID theft does happen, and still leave you to sort out the mess and try to fix your records. Accordingly, Krebs suggests that the best path is to consider freezing your credit file at the major credit bureaus. For those who aren’t familiar, a “security freeze” essentially blocks potential creditors from being able to view or “pull” your credit file unless you affirmatively unfreeze your file beforehand (which prevents ID thieves from opening lines of credit in your name, as the banks won’t lend if they can’t access your [frozen] credit file). Placing a freeze can usually be done online (though you may have to contact some via phone or in writing) for each of the four consumer credit bureaus (Equifax, Experian, TransUnion, and Innovis) and may have a small ($0-$15) fee, and once done you’ll receive a unique Personal Identification Number (PIN) that you can use to unfreeze your credit file in the future (e.g., if you actually want to apply for credit again). Notably, a Security Freeze is not the same as a Fraud Alert, which simply indicates to lenders not to grant credit in your name without first contacting you (but it only lasts for 90 days, though an ‘extended’ fraud alert can remain on your credit report for 7 years but only if you’ve already been the victim of ID theft). And either way, you’ll still want to review your credit report at least annually, which you can do for free through the government’s Annual Credit Report site. In addition, Krebs also suggests placing a security alert through ChexSystems (which many banks use to check when new customers request a checking or savings account), and to opt out of pre-approved credit card offers (which ID thieves often intercept and use fraudulently) via OptOutPreScreen.com.

Why Wall Street’s DOL Killer Threat – That ‘Millions’ Of IRA Investors Will Go Unadvised Under New Rules – Is Hogwash (Ron Rhoades, RIABiz) – The caution from SIFMA lobbyists and the Wall Street firms they represent is that if the DOL moves forward with its fiduciary proposals, that large firms will be ‘forced’ to stop rendering advice to the mass affluent and even smaller investors. Yet Rhoades points out that in reality, many major brokerage firms have already stepped away from such clientele, placing minimums on the size of accounts for their brokers (e.g., brokers are not compensated until the accounts are $100k, $500k, or larger), and shifting those consumers instead to call centers with limited or no advice at all. Though even more significant is that the brokerage industry doesn’t acknowledge that there are already other types of advisors and organizations that serve “small” consumers as well, and are eager to fill the void. For instance, the Garrett Planning Network has over 300 independent fee-only financial planners who provide fiduciary advice to people from all walks of life and without any account minimums, and NAPFA (the largest network of fee-only advisors) now has over 2,400 members providing fee-only fiduciary advice (and while some of those firms do have higher minimums, many do not, even amongst the largest NAPFA firms). Rhoades also notes our own rapidly-growing XY Planning Network (now approaching 90 advisory firms) that also provides fee-only fiduciary advice to consumers with no asset minimums (typically for a modest ongoing monthly fee). And even robo-advisors, while perhaps controversial in name, often operate with little or no minimum and are available for consumers that Wall Street claims will be abandoned. Though in point of fact, ultimately Rhoades suggests that Wall Street really may not intend to abandon investors at all anyway, even with the new rules; a similar threat was given back in 2005-2007 when the FPA litigated against the SEC’s ill-fated “fee-based accounts rule” and Wall Street firms said they wouldn’t be able to serve investors if they had to switch from fee-based brokerage accounts to investment advisory accounts, yet they had to make the switch and have continued to serve those investors after all. And if brokerage firms really are going to serve those small investors anyway when the time comes, then it’s all the more important to ensure that consumers who expect to receive objective and unconflicted advice get what they believe they are buying!

In the meantime, if you’re interested in more news and information regarding advisor technology I’d highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisors. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read “FPPad Bits And Bytes” on his blog!